Good Evening: U.S. stocks finished mixed Wednesday after a morning dip and afternoon rally both failed. Some less than cheery news from FedEx and some bank downgrades set the tone for the early weakness, while a successful test of the 200 day moving average by the S&P 500 helped prices rebound in the afternoon. And it is also quite possible that stocks were ready to bounce a bit after a few down days, but I’ll focus more on market direction tomorrow. Instead I will review President Obama’s proposal for changing the regulatory landscape of the financial industry. The issues that brought us the financial crisis are not small, but I wonder if some of the President’s many, many ideas on the subject are correctly sized in relation to the problem. More is not always better, especially when it comes to a complex industry like modern finance.

Stocks overseas were on the weak side overnight, extending a trend that began late last week. U.S. stock index futures were also a bit lower, though the news out of FedEx may have been a contributing factor (see below). FDX announced an earnings beat, but then went on to say the economy deteriorated during the most recent quarter and put an exclamation point on this observation by halving its earnings guidance for the current quarter. Since what is shipped by FDX is the very stuff that makes our economy go, hearing its management say — whether from 30,000 feet or on the ground — that the green shoots are not visibly sprouting gave many investors pause in the early going.

The economic data was not much of a factor, since the tame CPI figures reported today tell us little about the inflation risks down the road. So, too, with the current account deficit; it narrowed in Q1 due to factors that have already started to reverse (see below). The banks, however, were a story with a little more teeth this morning. In the final story you will find below, S&P downgraded 18 banks — despite all the stress test results and capital raises in recent weeks. It would have been an even bigger story had the ratings agencies not trashed their reputations in the 2003-2007 time frame.

Given this news flow, stocks could have been forgiven for opening 1% lower, but they instead opened nearly unchanged before declining by the aforementioned amount 90 minutes into the trading day. The S&P 500 even managed to penetrate its 200 day moving average for a brief spell before that index followed NASDAQ higher. After rallying until they were up approximately 1%, the major averages settled back to close mixed. Bonds were firm in the morning, but they also reversed to finish mixed. Yields on the short end fell a couple of bps, while those on the long end rose in equal measure. At least the dollar and commodities were fairly consistent, though. The former fell and stayed down, while the latter followed oil and precious metals higher for most of the session. The CRB index closed 0.4% higher.

I’ve written quite a bit about how the U.S. can more intelligently regulate our financial system. Back in May, I cited Barry Ritholtz’s suggestions for financial reform, which he posted in this article on his site, The Big Picture . In addition to Barry’s list, I proposed the following suggestions in a commentary posted later the same day (comment) . I then added these ideas to this growing laundry list on June 9 in this piece. The philosophy behind these proposals is to create a regulatory boundary fence inside which financial firms can then more or less freely operate. Detail-loving micromanagers need not apply for a position in this framework-oriented approach.

In response to all of the free advice available above and elsewhere, the Obama administration put forth in the Monday edition of the Washington Post the following preview of the President’s proposal. This early glimpse was heartening to the extent that it addressed many of the issues that Barry and I have written about. But, as always, the mischief of regulatory reform is in the details. President Obama’s actual proposal broadly follows the outline laid out by Mr. Geithner and Mr. Summers, but it goes quite a bit further — and, perhaps, too far (Obama’s Draft Proposal). Let me clearly state that I have yet to read every one of the 85 pages, but the pages I have read seem to indicate that when choosing between “smarter” regulation and simply “more” regulation, the President’s draft proposal seems to favor a “more regulation is better” approach.

The first piece of evidence I offer in support of my assertion of an unwelcome drift toward “more” as opposed to “smarter” regulation is the size of the proposal itself. “Change” mean many things, but 85 pages are more indicative of too much micromanagement rather than a statement of principals and intents to be debated during the legislative process. The blueprints for the type of “boundary fence” regulation I’ve often proposed would require a few pages; regulating the behavior of financial institutions while inside the boundaries is what takes so much explaining.

Another indication that the “more is better” philosophy of regulation might be transcendent in the President’s draft is an entire section (# 3) has as its goal to “protect consumers and investors from financial abuse”. Like 99% of the American population, I’m against financial abuse in all its forms, but it’s a fool’s errand to try to set up a vast infrastructure of rules to deal with it. The smarter approach would tell all investors and consumers to take responsibility themselves for any dealings to which they are a party. “Caveat emptor” would be my first, if inelegant, suggestion.

To those two simple words I would also offer ways for consumers and investors have easy access (800#, website, etc.) to both FINRA and the enforcement division of the SEC. FINRA could handle most of the brokerage-related complaints (think: my advisor did unauthorized trades in my account), and the SEC could handle the larger problems surrounding organizational practices (think: Stanford or Madoff). Both FINRA and the SEC already have the power to police, fine and/or prosecute perpetrators of financial misdeeds, so let’s just make it easy for folks to find help at these two regulatory bodies and then just ask the agencies to do their jobs.

See? My version of section # 3 alone would take only two paragraphs to explain, will cost next to nothing to implement, and will likely be more effective than any attempt to legislate even more “do’s” and “don’ts” than already exist. Sarbanes-Oxley is only one example of a confusing tangle of regs that has utterly failed to address the abuses it was intended to prevent. Conscientious objectors of the potentially higher staffing costs my idea might bring needn’t worry too much, since the extra funding the SEC might need could be found in eliminating certain departments (e.g. “Economic Analysis”).

Before anyone takes umbrage at what they may think is a political attack on the administration, let me say there is plenty to like about Mr. Obama’s proposal. I support 1) the overall approach to taking systemic risk into consideration instead of focusing only on individual institutions, 2) the imposition of leverage caps on these firms, 3) the move toward more transparency, 4) the desire to better coordinate the various regulatory bodies and their roles, 5) the attempt to finally rein in OTC derivatives, and 5) the goal of working toward international standards on all of the above. Done well, these changes will be quite welcome in that they will help lower the systemic risk embedded in our current system.

I’m less than enthralled, however, about 1) giving the Fed more power, 2) attempting to detail the ways we can now “protect” consumers and investors, 3) requiring hedge funds and “other pools of capital” to register with the SEC, and 4) skating past the moral hazard issues created by all the 2007-2009 bailouts. In short, Mr. Obama’s proposal is a start — one which I hope will emphasize intelligent attempts at regulation, but one I fear will end up just being more governmental ways to micromanage. This draft obviously will be subjected to considerable tinkering during the legislative process. Financial firms are huge campaign donors, especially in the Senate, so I’m guessing whatever our President eventually signs into law could be quite different than what he laid out today. Let’s hope Mr. Obama’s 85 pages of what looks like “more” get whittled down until we can proudly call them “smart”.

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

9 Responses to “Obama’s Regulatory Proposals — Smarter or Just More?”

I would like to see regulatory rules written in such a way as to evolve as the financial markets evolve, yet still have enough teeth to prosecute those who have a problem with prudent financial (common) sense or following the laws in the industry they have made a decision to play in.

I am less optimistic that spelling out explicit criteria as to what is legal (or what no longer is) will exploit an approach by the financial crowd to pay experts to come up with cracks in the code to continue the financial shenanigans that got us into this mess in the first place.

Financial institutions that are big enough to threaten the security of the entire financial system should be broken up. I know none of the financial institutions want to hear that; but, it is common sense. There are many accepted benefits to breaking up large companies releasing more targeted core competencies in each of the resulting smaller companies. This is a fact. It is just not one the financial industry wants to hear.

Lastly, the FED is at the core of the problems we now find ourselves in. Giving someone more power who has proven to be slow on the uptake or is politically compromised to the point that they can not do their job is the wrong direction to be going.

Had the FED not continually pushed down interest rates over the last 25 years as candy for the markets and friends of the FED, we would not find ourselves here now. Had the FED allows interest rates to move back up to a more traditional level between 5% to 10% during recoveries, this one thing alone would have provided more long term stability than any law that can now be written. With a reasonable cost of money, marginal projects rightfully so do not get funding. That is the way capitalism is supposed to work. Now, things are so short term oriented, all things financial are nothing more than gambles with your money.

It all starts and ends with the cost of money. The problem now is that we do not have the where-with-all to be able to return to a reasonable cost of money. We could never refinance the massive principle debt we have created for ourselves. The FED in retrospect is actually the most guilty party of all. Akin to creating more debt to solve our debt problems now is analogous to giving more power to the FED when the FED is a very large part of the problem it is now empowered to resolve. This caps a perverse line of thinking.

In answer to your Question…It has some good points; but, for the most part, IT IS JUST MORE of the same.

It is written with the benefit of hindsight. SMARTER to me means fewer clearly written high-level regulations and principles that provide the foundation for guidance and teeth for prosecution placing the onus back on the financial community to live up to their fiduciary responsibility. It feels to me like we are moving toward codifying every single wrong-doing. If it is not written down explicitly to be avoided then it is fair game to be exploited. Going down this path is a losing proposition with no end.

Having these, current, ‘Representatives’, in WDC, draft these ‘re-’ Regulatory Strictures is akin to allowing the incarcerated to build the new Cell Block.
Hidden Passageways? Surely, Not!~–ABCCBSNBCCNBSMSNBCFOX

A word about repackaging: Take for example the cereal box. Marketers are known to change the label, on an old cereal, by tacking on the emblem “new and improved.” Inside it is essentially the same cereal, with maybe one or two additives or preservatives, put in or taken out.

I have the impression that by writing “new” laws, fed board of governors or Treasury or advisers of same, are trying to skirt some important laws in existence.

It is hard to make a short list, but thankfully for all here, I will try.:)

U.S. Code Title 12, Chapter 16, § 1831 o Prompt Corrective Action (f)(2)(F) The appropriate Federal banking agency shall* carry out this section by taking 1 or more of the following actions … (F) Improving management. … (i) New election of directors. Ordering a new election for the institution’s board of directors. (ii) Dismissing directors or senior executive officers. Requiring the institution to dismiss from office any director or senior executive officer who had held office for more than 180 days immediately before the institution became undercapitalized.…

U.S. Code Title 12, Chapter 16, § 1831 o. Prompt Corrective Action (i)(1) and (i)(2)(A)(B)(C)(D)(F)1 …Restricting activities of critically undercapitalized institutions: To carry out the purpose of this section, the Corporation shall*, by regulation or order— restrict the activities of any critically undercapitalized insured depository institution; and at a minimum (emphasis added), prohibit any such institution from doing any of the following:

This brings me to an important consideration: Rewriting “new” law in the middle of the crisis, is a questionable practice in my mind. The current law seems to me, to be sufficient, if properly administered.

Like the idea of consumer watch dog entity that has teeth, but this seems like a small bone or traded off if they intend to continue to neglect important laws or seek to rewrite laws to change some of the more important laws above.

One law in particular, I would like to emphasis: U.S. Code Title 12, Chapter 16, § 1831 o. Prompt Corrective Action (i)(1) and (i)(2)(B) …Extending credit for any highly leveraged transaction.

Henry Paulson and Ben Bernanke, by way of omission, acted to enjoin Americans as guarantor for highly leverage transactions involving derivatives and guaranteeing transactions in the derivatives market. This is in violation of the above statute. This is opposed to letting banks involved in the derivatives market fail and be cast off into bankruptcy court (at least expense to tax payers).

(1) Purpose: The purpose of this section is to resolve the problems of insured depository institutions at the least possible long-term loss to the Deposit Insurance Fund. (IE: Least expense to tax payers).

(2) Prompt corrective action required: Each appropriate Federal banking agency and the Corporation (acting in the Corporation’s capacity as the insurer of depository institutions under this chapter) shall* carry out the purpose of this section by taking prompt corrective action to resolve the problems of insured depository institutions.

Frankly, I was happy with our capitalist market before the crisis, and I often marveled how the market had a nose for bad corporations and banks; would sniff them out and finally give them the boot. Kick the bad bank or firm out of the free market, and into bankruptcy – let us know that firm does not belong. Essentially the market would act like a homeowner to “clean out” the junk and excess from the garage. Work that needed to be done from time to time.

I was glad to see the market perform and I miss it terribly.

Back on point: Rewriting law?

In the PPIP and in the TALF programs to give incentive to private investors to partner with government, Mr. Geithner and Fed board of directors, are seeking to continue a course, to violate the established law at U.S. Code Title 12, Chapter 16, § 1831o. Prompt Corrective Action (i)(1) and (i)(2)(B) … Extending credit for any highly leveraged transaction.

From my perspective, I see the writing of “new and improved” law as un-necessary. If the treasury and board of fed wig-wearers, would stop interfering in the market, the market will act like it always has.

Rewriting law is about masking failures in leadership. Left alone, the market protects Americans from tyrannical rule of a few dishonorable leaders, who are making bad decisions.

The standing law is also sufficient, if simply upheld by good stewards.

A company cannot … seek to stay in business by transferring their debt obligation to others, who did not sign for it. This is not a good business practice.

We do not need new laws. We simply need people who will uphold the laws we have.

To borrow from Tony Blair, its not the law that is the problem, it is the people.

To date: The Federal Reserve Board of Governors, neither Treasury office, and neither of the last two administrations, have made an example of any firm.

From a regulatory perspective, this is not the way to reign in bad business practices.

Omission in the above mandates, serve to manage neglect on those who are being injured. Neglect of important laws, serves to enable favoritism and give competitive advantage to socially irresponsible firms (which are favored banks of the Federal Reserve entity).

Rewriting new law is about masking failure of key officers, to uphold laws that are already on the books.

It seems touched: to try to write new law, without first upholding the law that you have.

When dealing with the Savings and Loan problems, regulators at least made an example of some firms.

Granted some bad actors were not prosecuted like they should have been (more favoritism) but at least some firms were exposed for what they were doing that was socially irresponsible; resulted in making example of what is NOT desired. [See Home State Savings Bank of Cincinnati, Midwest Federal Savings & Loan of Minneapolis, Minnesota, Lincoln Savings and Loan, Silverado Savings and Loan, Imprudent real estate lending: many banks lent far more money than was prudent. (http://en.wikipedia.org/wiki/Savings_and_Loan_crisis#cite_ref-multiple1_4-0
)]

“It is instructive to note that the real estate boom and lending fiasco appears to have started in the United States….U.S. banks tried leveraged buyouts (LBOs) and Latin American loans. But the largest growth in lending was in new loans for commercial real estate.”

Under Paulson and Geithner, and by way of omission involving federal reserve oversight, we do not even have a 3rd party accounting firm reviewing the loan books of these firms, reviewing their compensation history and bonus records (in the ten years prior to 2008), nor the shareholder registries to see who has owned bank shares (for example are there any federal reserve board of governors who have benefited from the corporate practice of extracting cash from the balance sheet, to pay dividends, in prior ten year period, so that firm would have no cash in the 11th year or claim to be undercapitalized in some way, out of money).

They want to rewrite the law, and oh in the meanwhile, forsake scrutiny of where positive cash flow coming into the firm in the last 10 years, went out? Is bank claiming to be undercapitalized, giving money to profitable subsidiary entities, or sister firms? How much? How much does the mother firm give to its children, annually, in the last 7 years, that it would come now in the 8th year and say it is out of cash?

(Been running around the mansion wearing the wigs too long. Playing make believe they are regulators. Now they want to rewrite the law? Of course. …Matilda, come out of the kitchen and give these “regulators” some milk and some cookies.)

though, maybe more simply, there cannot be any kind of ‘Transparency’ of the kind(s) you give rise to. For, surely, if the full-scope of the looting was made known, the “Wall Street/WDC”-axis would, forever, be spindled.
~~
Also, the ‘media cluster’ was meant to stand-in for the idea that the MSM, speaking with a single voice, aids and abets the chicanenery of WDC, and its cohorts..http://www.thefreedictionary.com/chicanery

@Alfred, I see your Highway to Hell, and I raise ya Voodoo Child. … O’ Jimmy say: U see a regulator who want tah rewrite da law in the middle d’stream … Its a Voodoo Child. … Lord Knows, thats a voodoo child!!

Say Hello

About Barry Ritholtz

Ritholtz has been observing capital markets with a critical eye for 20 years. With a background in math & sciences and a law school degree, he is not your typical Wall St. persona. He left Law for Finance, working as a trader, researcher and strategist before graduating to asset managementRead More...

Quote of the Day

"The largest Asian central banks have gone on record that they are curbing their purchases of US debt. And they are also diversifying their huge reserves, steadily moving away from the dollar. The risks have simply become too many and too serious." -W. Joseph StroupeEditor, Global Events

Sign Up For My Newsletter

Get subscriber only insights and news delivered by Barry every two weeks.